Posts Tagged ‘same-sex couples’

Income tax filing season is upon us, and so it’s an appropriate time to turn our attention to what’s new (or little-known) in the income tax world. We’re particularly interested, of course, in income tax issues that affect our clients, who usually are more interested in estate and gift taxes than income taxes. But there’s one subset of our clientele that really does need to focus on new income tax rules: same-sex married couples.

What’s new this year, of course, is that the U.S. Supreme Court has struck down a key part of the federal Defense of Marriage Act (DOMA). That federal law had said that even if a state chose to recognize same-sex marriages, the federal government would not accept that state recognition. After the Supreme Court ruling in United States v. Windsor on June 26, 2013, that principle was reversed. Later interpretations by the Internal Revenue Service (along with other agencies of the government) have expanded that reversal.

In the wake of the Windsor decision, the executive branch of the federal government has adopted a new approach to determining the validity and effect of same-sex marriages. The short version: if the marriage was recognized as valid where and when it was solemnized, it will be valid for federal (including income tax) purposes. That has been referred to as the “place of celebration” rule. It is sometimes called the “state of celebration” rule, but it is not limited to states — a marriage valid in a foreign country will work, too. Like, for one example, that of Edith Windsor and Thea Spyer, who were married in Ontario, Canada, in 2007, but lived in New York.

We still see a lot of confusion about the effect of the new IRS rules, though. Our gay and lesbian clients often believe that they are not married because Arizona does not (yet) recognize the validity of their marriage. Sometimes same-sex couples were married years ago and have since drifted apart — believing, perhaps, that they did not need to do anything to end a marriage that their home state stubbornly refuses to acknowledge. The new rules will require a rethinking of those relationships.

Here’s the bottom line for same-sex married couples: if you were legally married in another state or country, you need to file your federal income taxes this year (and for future years) as if you were married — because you are. That may mean that some couples actually pay more in total income tax — the well-known “marriage penalty” in the federal tax code will now apply to same-sex couples in the same way that it has long applied to opposite-sex couples. But it is not optional — a married couple, regardless of gender, can not decide to simply file as two single individuals regardless of what Arizona thinks of the validity of their marriage.

Does that mean that married couples who are no longer together need to file a joint income tax return? Yes — or they have to file as “married, filing separately.” Does that mean separated — but still married — couples have to communicate with each other, and share financial information? No, but if they file separately they are likely to pay more total tax, and it makes sense to talk through the options with a qualified income tax preparer.

Why is there a 2012 version of Arizona’s Schedule S? That leads to another point worth considering: if you were married before 2013, you may be eligible to (but you are not required to) amend your federal income tax return to file as a married couple. If you do, you will need to amend your Arizona tax return as well. You clearly have the right to amend your 2012 return, and you may be eligible to amend for 2011 as well — but note that if you amend for 2011 you will also need to amend for 2012 at the same time. Amendment rules are confusing, but the IRS has attempted to make them understandable on their generally excellent website.

There are other tax-related issues concerning same-sex marriages, and more opportunities for federal and state tax law to diverge.One we saw in our office this month: a surviving partner visited with us after the death of her long-time partner. She never mentioned that they had been married, thinking (as she later told us) that the marriage was not valid in Arizona. But when it came time to look at her partner’s Individual Retirement Account (IRA), it made a difference — even in Arizona. As a surviving spouse she had the ability to simply roll over her spouse’s IRA and continue to defer withdrawals until she reaches 70 1/2. If they had not been married she would have been required to begin withdrawals immediately, and faster. The lesson: don’t assume that Arizona’s failure to recognize your marriage means that it has no effect.

Most of the other changes, however, are considerably more arcane; the requirement that same-sex married couples file their federal returns as married (whether separately or jointly) is not arcane, and will have a big impact on those pioneers who got married in another state or country. Ask for advice, and share your marital status with your lawyer and your tax preparer.

Just a few weeks ago we wrote about some of the uncertainties facing legally married same-sex couples living in states (like Arizona) that refuse to recognize the validity of their marriages. If a legally-married couple moves to Arizona, we wondered, would their ability to receive some of the tax benefits available to married couples change just because their new state did not recognize or approve of their marriage? We suggested that same-sex couples ought to be aware of the problem, but assume that they should be able to enjoy the same benefits (and burdens, for that matter) available to their married heterosexual friends.

Well, the United States government weighed in on the subject this week, and the positions taken by two different federal agencies made it clear that a valid marriage is a valid marriage — at least in the federal government’s eyes. The result? Same-sex couples still need to pay extra attention to their estate planning choices, but their choices will be much more palatable.

On August 29, 2013, the Internal Revenue Service released Revenue Ruling 2013-17. Its bottom line: if you are legally married, even though your current state of domicile does not recognize it, you will be treated as married for all tax purposes. Period. Income tax, estate tax, gift tax — it makes no difference. You are married.

In our earlier newsletter we talked about a couple, married in Massachusetts, who had moved to Arizona. Could they file their federal income taxes as “married, filing jointly”? Could they list one another as beneficiary on their IRA or 401(k) accounts, relying on the ability of a spouse to roll those benefits over into a new IRA? Would they get the benefit of a full step-up in basis for income tax purposes, just like other married couples holding community property? It was not clear a week ago. Today it is clear. The answer in each case is “yes” — though perhaps a qualified “yes” in one or two of those cases.

Why a qualified yes? Mostly because community property titling is a special case. Yes, there are federal income tax benefits for married couples titling their assets as community property — but the availability of that option is governed by state property law. Arizona is one of the handful of states recognizing community property designations at all, and it limits the option to couples it thinks are married. If a same-sex couple, legally married in another state, attempts to title, say, real estate as community property (or community property with right of survivorship), will Arizona recognize that title?

We are not sure, and so suggest that the safe approach is to create a trust (probably a joint, revocable trust), provide that all the assets in the trust are held as community property, and title most assets to that trust. That does mean that same-sex couples will end up paying somewhat more for their estate planning than their married heterosexual friends — but they will get the same result at a relatively modest cost.

The other notable change on the federal level involves long-term care arrangements for Medicare recipients. It is far less expansive than the big IRA announcement, but reflects the same general approach: married same-sex couples are to be accorded the same benefits as married heterosexual couples, at least on the federal level.

An August 29, 2013, announcement from the Department of Health and Human Services affects Medicare Advantage beneficiaries. It is not very far-reaching, but it is nonetheless important. In cases where one spouse is already admitted to a skilled nursing facility (what most of us call a “nursing home”), when the second spouse requires placement he or she must be permitted to choose the same facility. In other words, Medicare Advantage plans must have rules supporting spouses’ ability to stay together. And those policies must apply to same-sex married couples, too — even if their marriages are not recognized in the state where they live.

Why is this modest change important? Because, like the IRS declaration, it indicates that the federal government will be extending protections to validly married same-sex couples regardless of their state of residence.

Legal rights and responsibilities are evolving quickly for same-sex marriage. The first few states permitting same-sex marriages debated whether to even permit out-0f-state couples to marry. In the next wave of legal developments, it seemed clear that couples living in Arizona probably would not benefit from traveling to, say, Canada or Iowa to get married, only to return to Arizona and have their marriages all but invalidated. This week’s announcements make it clear that a committed same-sex couple should seriously consider whether they want to get married in a friendlier jurisdiction, even if they intend to return to Arizona to live.

The federal pronouncements also make it that much more difficult for states like Arizona to continue to resist the pressure to change. If a legally married same-sex couple, living in Arizona, wants to get divorced, do they have access to the Arizona court system? The current legal thinking in Arizona is that they might be able to seek annulment of their marriage (which, in Arizona’s legal view, never validly existed), but not a divorce (or dissolution).

Consider, for instance, the dilemma facing Phoenix-area resident Anne Armstrong (not her real name) earlier this year. She and her partner Roberta Reynolds had been married in California, but Anne wished to end the marriage. She filed a petition for annulment of the marriage in the Arizona Superior Court in Phoenix. Roberta did not respond, but the Judge Eartha K. Washington nonetheless refused to annul the marriage. Because same-sex marriages are invalid in Arizona, ruled the judge, there was nothing she could do to help Anne end her California marriage.

The Arizona Court of Appeals reversed that decision and sent the case back to the judge for further proceedings to annul the marriage and divide the couple’s property. Atwood v. Riviotta, May 16, 2013. While Anne’s legal problems were addressed, the decision left two huge issues unresolved: (1) what about same-sex married couples who don’t want to end their marriages, and (2) why should the legal process for ending same-sex marriages be different in the first place? Furthermore, the Court of Appeals resolution was by an unpublished decision, meaning it could not even be cited as precedent for other, similar cases as they arise.

What about resolution of child custody issues, or property divisions? What about bigamy laws, or other societal norms affecting married couples? If a couple is permitted to file income tax returns as married under federal law, why should it be different for state income tax returns? The pressure on Arizona (and other resistant states) is intense: it is time for our legal system to deal with changes sweeping across the country, and the federal government’s pronouncements this week will add to that pressure.

Last week we saw a married couple in our office. The couple had come to us for estate planning. They did not have children with disabilities, or spendthrift sons-in-law or daughters-in-law. Their assets were not unusual (some Arizona real estate, a brokerage account, several bank accounts). Their net worth was well under the $5.25 million that would have made us want to talk about federal estate tax issues. They intend to leave their estates to one another and, on the second death, to relatives and a few charities. In short, they were a pretty typical couple.

This couple already held everything they owned as “joint tenants with right of survivorship.” That, of course, means that on the death of the first partner, the survivor would receive everything without having to go through the probate process. Ordinarily we would have told them that they ought to have fairly simple wills and Arizona powers of attorney. We would have suggested that they transfer all their real estate and brokerage assets into “community property with right of survivorship.” That’s a slight improvement on joint tenancy because on the first death the survivor gets a stepped-up income tax basis on the entire value of assets held as community property. It is an option that is only available to married couples, and it’s usually worth considering.

Though our couple was married, they did have one legal issue that complicates their estate planning. They are both of the same gender. They got married in another state, where same-sex marriages are recognized, and then retired to Arizona. They are looking forward to enjoying the sunshine, outdoor recreation opportunities, and casual lifestyle of The Grand Canyon State. Though Arizona was once known as The Valentine State (do you know why?), our state Constitution expressly invalidates this couple’s marriage.

Or does it? They have arrived in Arizona at a time of legal ferment. The U.S. Supreme Court has invalidated a federal ban on same-sex marriages; is invalidation of Arizona’s ban (and those in place in dozens of other states) far behind? And, more importantly for our couple, what are legally married gay couples supposed to do in the meantime?

Reasonable minds can differ on what our couple should do. In fact, we are fond of saying that if you get ten lawyers in a room and discuss legal issues, you will get at least twenty firmly-held, well-reasoned opinions. But here is what we discussed with our clients:

Consider creating a joint revocable trust. Declare in the trust that everything you own is community property, and file any future tax returns on that assumption. The worst that could happen would be that the IRS ultimately disagrees, and then you are back where you would be if you did nothing of the sort. BUT note that the establishment and funding of a trust is more expensive (by, perhaps, a factor of three or four), and opposite-sex married couples don’t have to go through this kind of silliness.

At least create reciprocal wills, and guard them more carefully than opposite-sex couples need to. If a couple whose marriage is recognized in Arizona never get around to making a will, or misplace their wills, it is likely that the default rules will follow what they wrote in their wills. If the marriage is not recognized, though, a missing will could mean biological family members of the deceased spouse take in preference over the surviving spouse — or at least that litigation is required to establish the validity of the out-of-Arizona marriage.

Critically important for gay couples, married or not, is signing of a document directing funeral arrangements and disposition of remains. Time and again we have seen same-sex partners shut out of funeral and burial arrangements, even by family members who professed affection for the surviving partner in the hours before death. The advent of same-sex marriages might turn out to have eased that kind of pain, but it may be yet another opportunity for litigation, and at a time of high emotional fragility.

Go ahead and try putting real estate and brokerage accounts in “community property with right of survivorship.” Expect a little different experience between stockbrokers and the County Recorder; the former is probably used to same-sex community property declarations, and the latter probably thinks it has a responsibility to uphold Arizona’s misguided law. Do you want to be a little bit subversive and act as an agent for positive change, albeit a small change? Talk with us — we like both of those ideas.

Review and update your plans more often than other couples need to. We usually counsel that estate plans have about a five-year life, and we expect to actually see clients again in about 7-10 years. Same-sex married couples ought to shorten that to 3-5 years, as there will be changes AND we want to have recent documents in the ultimate time of need (that’s a not-very-disguised euphemism for “when you get sick or die”).

We were very chagrined to have to advise this delightful couple that Arizona is so unwelcoming. We really want to help them secure the benefits of their marriage in Arizona. We can accomplish almost everything that an opposite-sex married couple can get with their Arizona-recognized marriage, except for the (admittedly small) income-tax benefit of “community property with right of survivorship” titling. But we can’t really tell our couple that they have a moral or legal duty to carry the torch for change in this arena, because the reality is that the benefit is modest for most couples. That’s because:

Your real estate may well appreciate during your life, but if the only real estate you own is your residence then you already get a significant income tax avoidance opportunity (up to $250,000 in gain) without regard to your marital status. Be careful about relying on this as your sole tax-avoidance technique, but for most people it means that they will not ever pay taxes on increases in their home’s value anyway.

Although capital gains in your stock holdings do not have the same partial exclusion opportunity, it is still easy to avoid paying income tax on the increased value by simply not selling the stocks. That means that an “unmarried” couple like our clients would have lost flexibility, not cash — still a negative, but not with as obvious a dollar cost.

For our part, we are looking forward to a time (we hope that it is soon) when these kinds of distinctions are no longer necessary. Meanwhile, we wish the very best for all our clients who have retired to The Valentine State.

Gay and lesbian couples need to take special steps to make sure that their wishes are carried out at death. The law makes some assumptions about the intentions of married couples—that they usually intend to leave their property to one another, for example. There are also tax rules benefiting married couples that are not available to same-sex couples.

Mary Scott and Lucille Horstmeier lived together in Illinois for nearly twenty years. Ms. Horstmeier was a locally prominent businesswoman, while Ms. Scott managed the household, handled the couples’ finances and took care of housework and repairs. For some of the time they lived together, Ms. Scott worked at the school Ms. Horstmeier managed, but her earnings were considerably lower than her partner’s.

In 1975 the two women moved into a new home in Glenview, Illinois. Ms. Horstmeier made the down payment and all subsequent payments, and took the title in her name alone. While Ms. Scott contributed some of her earnings to the household over the ensuing years, she never contributed directly to the mortgage payment on the home.

Ms. Scott maintained that the two women agreed that they would own the home jointly, and that her name was left off the title only because she did not have a down payment or a steady income at the time they bought their home.

One problem that frequently arises in similar situations can occur when the couple separates, or one partner dies, and no arrangement has been formalized for division or transfer of the property. Ms. Horstmeier, however, had planned for her own death—she made a will leaving all her estate to Ms. Scott and naming Ms. Scott as her executor.

When Ms. Horstmeier died in 1993, however, there was still a problem. Because she had been successful her estate was large enough to incur an estate tax liability. If Ms. Scott could have been treated as a surviving spouse there would have been no problem, since estate tax law permits an unlimited amount of money and property to pass to a spouse without tax. But Ms. Scott’s problems with the IRS were even larger.

Since she believed that she was already a one-half owner of the couple’s home, Ms. Scott reported only half the value of the home (minus half the remaining mortgage) on Ms. Horstmeier’s estate tax return. The IRS disagreed, insisting that the entire home had belonged to Ms. Horstmeier. The distinction was important, since the IRS position produced an additional $157,404 in taxes.

The IRS position prevailed in the Tax Court, and Ms. Scott appealed. The appellate court agreed with the Tax Court, and ordered the tax paid. Scott v. Commissioner, September 8, 2000.

What could Ms. Horstmeier and Ms. Scott have done differently? They could have taken the title in their joint names and made joint payments on the mortgage, or even signed a written agreement in advance. The planning they did complete was good—without it the home might have gone to Ms. Horstmeier’s relatives instead of Ms. Scott. They should also have anticipated yet another problem facing same-sex couples in their effort to achieve the benefits routinely available to married partners.